Investors Need to take Responsibility for Their Own Actions

- 29 July 2010

Investors need to take responsibility for their own actions when it comes to making or losing money in the share market.

The recent review of the CFD industry by the Australian Securities and Investments Commission (ASIC) has thrown the spotlight on one of the fastest growing sectors of the financial services industry. Love them or hate them, it seems that their ever growing popularity will ensure that CFDs are going to be around for a long while still. Whether arguing for or against CFDs one should always argue from a position of complete understanding. I’ll attempt to set the record straight on a few issues regarding CFDs today.

CFDs are potentially the most revolutionary financial markets tool introduced into Australia in the last decade. They have allowed traders to access a wider range of markets for a fraction of the costs charged prior to their introduction, and to play both rising and falling markets. In terms of giving investors the opportunity to generate significant returns from the market and simultaneously protect their capital, they’ve had few peers in the financial services industry. In spite of this, there’s been plenty of talk recently regarding how risky CFDs are and how they’ve been marketed to unwitting retail investors.

Certainly there’s been plenty of scaremongering from the vocal anti-CFD lobby including a number of traditional brokers and elements of the financial press. Incredibly, CFDs have been described by ASIC itself as being “No better than a flutter on the horses”. Given this prior dim view of CFDs, it is unsurprising that the regulator has decided to take a similarly dim view in its latest regulatory guide.

The major thrust of the guide is that CFDs are unsuitable for the majority of unsophisticated retail investors. I couldn’t find an official definition for an unsophisticated retail investor, however there is a well known official definition for a “sophisticated” investor in the financial services industry:

“It appears from a certificate given by a qualified accountant no more than 6 months before the offer is made that the person to whom the offer is made:

(i) has net assets of at least $2.5 million; or

(ii)has a gross income for each of the last 2 financial years of at least $250,000 a year.”

So, as far as the industry is concerned it seems that money is the only thing which buys you sophistication! Regardless of how much cashola a punter starts off with, my experience is that the size of your bank balance has very little to do with your ability to grow that balance. There’s an old joke amongst professional traders, “How can a punter finish up with a million dollars after their first year in the share market?” Answer: “Start with two million!”

Whether they’ve got a pittance to invest or millions, most investors simply aren’t equipped with the technique or the mindset required to make money in both rising and falling markets, and especially during periods of extreme market volatility much like we are seeing right now. Even more dangerously, most investors drastically overestimate their abilities when it comes to investing and assume that they will be able to master the markets with little-to-no experience.

ASIC notes that: “Many retail investors appear to be over-confident in their understanding of CFDs and their ability to successfully trade them.” This is not uncommon for any type of investing – CFDs or otherwise. Many investors assume that success in other fields like a profession, or positive returns from other types of investments like property, will guarantee success in the share market. They believe that they’ll be able to take the same skills learned in these pursuits and apply them equally as successfully in the share market. Unfortunately far too often this simply does not happen and money is lost.

Ironically, the worst share investors and traders are often those who are the most educated in their “normal” lives. In my experience, more often than not it’s doctors, lawyers, dentists, and engineers who make the worst traders! The share market is unlike anything most have ever tackled before and an excess of book smarts rarely equates to an excess of profits. In fact success in the share market requires one to often think in total opposition to what makes sense in other fields of investing like property, but this is probably a topic for another time! Bringing this discussion back to CFDs, ASIC also found that:

“The majority of investors do not seek or receive personal financial advice prior to investing in OTC CFDs”…many retail investors:

are confused as to how CFDs operate, and do not appreciate the risks associated with trading CFDs;

often do not receive sufficient information to make an informed decision about whether or not to acquire CFDs;

have difficulty understanding the information they do receive due to bias, poor presentation and subject complexity; and

as a result, do not always make informed and confident financial decisions about whether CFDs are a suitable investment for them

With this in mind, I think that it’s a flawed argument to say that CFDs are risky or not risky. CFDs are just a tool which investors can use to improve their returns and manage their risk in the markets – much like a nail gun or a circular saw is for a carpenter. Neither a nail gun nor a circular saw are dangerous in the hands of an experienced professional meticulous about his safety, however put them in the hands of an apprentice who has not yet had any guidance…and the results could be disastrous (imagine spurting blood and a dash to emergency with a finger in a lunchbox!). Those looking to make consistent and sizeable returns in the share market face the exact same situation when dealing with CFDs – or any other security for that matter.

CFDs aren’t a risk to investors’ wealth – rather it’s the pervasive lack of understanding of what constitutes good investing practice.

You see, plenty of people have done just fine losing a whole heap of money trading plain-old vanilla shares lately. It’s been just as easy to blow up your superannuation account trading shares, warrants, options or anything else. Interestingly, each of these three products is offered to practically anyone by share brokers and financial planners and advisers – sophistication is rarely a consideration. All have the apparent safety of being tradeable on the Australian Securities Exchange (ASX), yet despite this fact, many unwitting investors have lost their shirts trading them for decades! Interestingly however, none of these products have drawn any extra scrutiny from the regulators since the global financial crisis; but CFDs have. This appears to be a double standard. Certainly there are parties who have a vested interest in perpetuating the myth that ASX listed products are “safe” and over the counter CFDs are “risky”.

I believe that to stop people losing money trading CFDs, or any other security for that matter, investors need to improve their understanding of what constitutes good investing practice. Investors need to stop blaming everything and everyone else for their poor performance in the markets, and take responsibility their own actions. Either seek out the correct education before you get involved – or don’t complain when it all goes wrong when you don’t!

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